- Economic Advisory Group stresses the need for meaningful reforms to achieve sustainable growth, instead of relying on policies that become a source of economic instability
ISLAMABAD: The Economic Advisory Group (EAG) has expressed serious concerns regarding the inadequate response from the State Bank of Pakistan (SBP) in pre-empting the ongoing crisis. Instead, the EAG argues, the SBP’s response, both in terms of setting the policy rate and interventions in the currency market – first through spending forex reserves and then through administrative measures – has only exacerbated the crisis.
EAG continues to stress the need for meaningful reforms to achieve sustainable growth, instead of relying on policies that become a source of economic instability.
The SBP has continued to maintain a significantly negative real interest rate during the fiscal year 2023. This was done despite the need to decrease the external financing gap to a more sustainable level. The real interest rate in Pakistan at the start of the fiscal year 2023 stood in the range of minus 5-7% on the forward-looking basis. This is particularly noteworthy, as it was in sharp contrast to the trend in the rest of the world.
Around the same time, according to the IMF October 2022 Financial Stability Report, the short-term median real interest rate on the forward-looking basis in Latin America had increased to 5%. Likewise, the median real rate for Asia and Central & Eastern Europe had increased to 1% and 3%, respectively. In contrast, according to Bloomberg, the real interest rate in Pakistan was the second lowest in the South East Asia region as of July 2022.
It is concerning that the SBP continues to remain behind the curve. The recent statements by the SBP Governor make clear that the SBP’s inflation projections underlying its decision to increase the policy rate by 100bps are flawed. The SBP Governor asserted that the true value of the exchange rate was close to Rs230 per US dollar. The sharp rupee depreciation in the following days puts a question mark on the credibility of the SBP’s decision making process behind the recent monetary policy decision.
Despite some concerns, the EAG had overall welcomed the 2021 legislation that granted greater autonomy to the SBP and adopted inflation targeting as the monetary policy regime. Unfortunately, the SBP has made no progress in achieving its stated objective of stabilising inflation around 5-7%. As per the SBP’s survey of forecasters, the long-term inflation expectations continue to remain unanchored at close to 9%. The implied inflation expectations based on long-term government bond yields are arguably even higher. This suggests that the SBP will continue to miss its inflation target over the medium term.
The SBP’s performance in ensuring financial stability is also unsatisfactory. As of 20th January 2023, the SBP reserves had declined to only $3.7bn. This decline in reserves can be traced back to September 2021. Since then, the SBP has used reserves to fund the gap between forex inflows and outflows, and in doing so, prevented the exchange rate from adjusting in response to market forces.
It is difficult to believe that during much of this period, policymakers at the SBP did not have information on the expected worsening in the global financial conditions, and the impending external debt servicing requirements in subsequent months. Yet, the SBP continued using reserves to bridge the financing gap, instead of using a combination of increasing the policy rate and resorting to a market-based exchange rate regime.
These policy decisions exacerbated the already precarious situation Pakistan faces today, due to the sharp increase in external debt servicing burden since 2013. The SBP Governor has stated that, excluding a $3bn rollover, Pak still needs to make a payment of $2.2bn under a bilateral-commercial arrangement, another $2.8bn which he did not clarify, and $1.1bn in interest payment during the next five months. With reserves already as low as $3.7bn, the debt servicing burden during the next fiscal year will present an even greater challenge.
The EAG recognises that there is a need for cooperation between the fiscal and monetary authorities to achieve desired macroeconomic objectives. However, the EAG is also of the view that the SBP has fallen short of using the autonomy that it was granted by the parliament to deliver on its mandate. In effect, by insisting on preventing the exchange rate from fully adjusting while not backing it with an appropriate interest rate stance, the SBP only contributed to the instability that it was mandated to prevent.
The transparency that comes with the adoption of a stated inflation target under the inflation targeting regime plays a crucial role in making the central bank accountable.
Copyright Business Recorder, 2023